States and Towns Lean on Taxpayers

By

Conor Dougherty

Updated Sept. 26, 2009 12:01 a.m. ET

State and municipal governments, struggling with sinking revenue, are raising money by levying fees on consumers, slapping local businesses with back taxes and tweaking tax laws in ways that force many businesses to pay more.

That is leading to accusations -- and, in some cases, lawsuits -- that governments are trying to rake in more money without officially raising taxes, sometimes illegally.

The San Francisco Board of Supervisors, which can't easily raise taxes without a referendum, has approved a controversial cigarette "fee" of 20 cents a pack that takes effect next month.

Last week, five retailing groups sued New York state alleging that a new tobacco-registration fee was unconstitutional. The groups argued the new fee, which uses a sliding scale based on a retailer's total sales, instead of just cigarette sales, "is essentially a tax," said Andrew Curto, a lawyer representing the groups.

Across the nation, lawyers say municipalities are stepping up audits of businesses in a hunt for back taxes. "We have several cases right now that are at the audit stage, and the localities are taking very aggressive stances," said Eric Tresh, a partner in the Atlanta office of corporate law firm Sutherland Asbill & Brennan. "We're going to see a lot more of these cases in court."

After an audit last year, the city of Sandy Springs, Ga., sent locally based electricity producer
Mirant
Corp.
a tax bill for about $14 million in occupation tax, including interest and penalties, for 2006 to 2008. That compared with a bill of about $85,000 in occupation tax -- a kind of sales tax levied on companies instead of consumers -- that the company paid in 2005.

Mirant fired back with a lawsuit alleging the city's reading of Georgia tax law was "erroneous and unlawful."

A few months later, Mirant saw some relief as Sandy Springs retroactively capped its occupation tax at $400,000 a year, resulting in Mirant owing about $1.2 million -- still about $1 million more than what it believes it owes in taxes.

The city said it is simply collecting its due. "Our ordinance is valid, and we are in court defending our right to collect the tax," said Wendell Willard, the city's attorney.

In San Francisco, tax lawyers say the city is sidestepping the electorate by labeling the new cigarette levy as a fee instead of a tax.

A spokesman for San Francisco Mayor Gavin Newsom said the fee only would recover the annual cost directly tied to cleaning up cigarette butts.

States' tax revenue fell 11.7% in the first three months of 2009, the steepest decline on record, and collections have gotten even weaker since, according to a recent report by the Nelson A. Rockefeller Institute of Government at the State University of New York.

Falling business profits and consumer skittishness have crimped income and sales taxes. At the local level, falling real-estate values have forced cities to lower property taxes -- the primary source of funding in many places.

Nobody tracks the number of states or municipalities that have more broadly interpreted their tax laws to make up for these lost revenues, or the number of lawsuits challenging them.

But local tax lawyers and organizations that represent corporate taxpayers say such disputes often go up in a slowing economy, and are on the rise today.

"Companies are feeling besieged by the increased aggressiveness of certain state departments of revenue," said Doug Lindholm, president of the Council on State Taxation, a group that represents state taxpayers.

One of the more common disputes involves what tax lawyers call "nexus," or rules that guide what businesses the state can and can't tax.

The most well-known example is New York's "Amazon law," which refers to a state law that requires online retailers to collect local sales taxes even if the company has no physical presence in the state.

Amazon has challenged the law in court, lost and is now in appeal. Rhode Island and North Carolina have passed similar legislation.

Among the more aggressive states has been California, which teetered on the brink of insolvency during a budget impasse earlier this year.

In addition to new taxes and employee furloughs, the state's legislature recently passed a 20% surcharge on companies that underpay taxes by $1 million or more.

California has also revised its tax code to clarify the definition of what it means to do business in the state. A company is doing business there if, among other things, its California sales are 25% of total sales or more than $500,000, whichever is lower.

The old standard stated that companies doing business in California were those "actively engaging in any transaction for the purpose of financial or pecuniary gain or profit" -- an ambiguous statement, but one that many lawyers took to mean that a company had to have a physical presence in California to be subject to tax.

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